The minutes from the 26-27 January FOMC meeting suggest the Fed is nervous about a lot of things: falling equity prices, wider credit spreads, an appreciating US dollar, increased financial market volatility, falling inflation expectations, valuations in commercial real estate, further divestment in the energy sector and running out of monetary ammunition to combat a crisis. Not to mention adverse developments abroad.
What was clearly absent from the January FOMC minutes was a list of upside risks. A mention of (backward-looking) impressive labor market data was as near as it got. Where there was any color on the differences from the general view, it was one way – to the downside.
We saw three themes from the minutes:
- The Committee has seen tighter financial conditions than expected;
- The risks to the outlook are decidedly to the downside; and,
- The Committee is uncertain about what 1 & 2 mean for is medium-term outlook.
Tighter financial conditions
- Almost all participants saw developments as having tightened financial conditions in the US, though whether this was expected to persist was unclear.
- “The effects of these financial developments, if they were to persist, may be roughly equivalent to those from further firming in monetary policy”.
- The effects of more uncertainty and tighter financial conditions on the economy remained to be seen.
Risks
- “Many” participants thought downside risks had increased, with a “minority” already concluding that the risks are no longer balanced.
- Most judged it “premature” to alter appreciably their medium term economic outlooks. This, at least, contemplates a sizeable shift in the future.
- The staff said the risks to their own GDP forecasts were weighted to the downside.
- A number of participants viewed the inflation outlook as more uncertain or saw the risks as being to the downside. The staff saw risks to their own inflation forecast as being to the downside.
- “Several” argued that monetary policy had less ammunition to deal with downside shocks to inflation and growth than upside shocks, and so thought it prudent to wait for additional information on underlying developments in growth and inflation before making the next hike.
Uncertainty
- The Committee was very uncertain about how markets and overseas developments would perform.
- A “few” FOMC members wanted to see direct evidence that inflation was rising towards 2% as an important element in their assessment of the appropriate policy path.
- It was noted that, while generally monetary policy should not respond to temporary shocks to inflation, it depended on the shocks not affecting longer term inflation expectations.
We found few surprises in the FOMC minutes, aside from a more direct admission of a greater weight being given to labor market indicators than economic activity data (GDP) and that “monetary policy was less well positioned to respond effectively to shocks”. We are living in a scary world when the FOMC openly admits that it has limited ammo – something the staff took one step further in saying that fiscal policy is also limited in this sphere.
Our view is that the Fed will be locked out of hiking rates throughout 2017 (see more here) and we see a significant risk of recession (see more here). Today’s minutes reiterate our concern that, if market turbulence keeps the Fed from hiking now and the economy slows later this year, as we expect, the Fed will find it difficult to re-engage its tightening cycle.
